The Chronicle of Philanthropy

For Charities, a New Twist in Raising Money: Corporate Investors in Life-Insurance Policies

By DEBRA E. BLUM

The Christian Medical & Dental Society, in Bristol, Tenn., expects to earn $1-million a year for the next 30 years by participating in an unusual and intricate new life-insurance program.

In the program -- which its promoters say is risk-free for charities and easy for them to participate in -- the medical group uses money collected from corporate investors to purchase thousands of life-insurance policies. All the group has to do is pay about $100,000 in administrative costs and recruit people to allow it to buy life-insurance policies in their names.

So far, 3,500 people have volunteered. The medical group will earn its money as those people die, and their heirs will get a small slice of the death benefits from the insurance policies as well.

Also standing to gain: Capital Partners Funding Group, the Chico, Cal., company that developed the program, and the investors that it recruits to put up the money with which the charities will buy the insurance.

The program is the latest example of a growing number of plans marketed by for-profit financial companies that use insurance policies to earn money for charities.

In recent months, the Internal Revenue Service has cracked down on at least one controversial scheme -- known as charitable split-dollar insurance -- in which charities and wealthy donors divide the proceeds of life-insurance policies bought with tax-deductible dollars. Congress also is moving to outlaw the practice.

Programs like those promoted by Capital Partners operate very differently from the split-dollar plan. Most significantly, they don't offer any of the participants the option of a charitable tax deduction -- which in part caused the split-dollar plan to come under attack.

Nonetheless, legal experts say that, depending on exactly how the deals are structured, some elements of programs like the one promoted by Capital Partners may run afoul of charity, insurance, and securities laws. And financial analysts say charities need to be very careful to determine whether the plans -- even if they pass legal muster -- will really be able to back up their promises with sound financial returns.

Though Capital Partners has yet to publicly unveil its plan, it says at least nine charities, including the Tennessee society, have agreed to participate. It won't name the other participants, but The Chronicle has learned that the Grand Traverse Area Catholic Schools, in Michigan, has been marketing the plan.

While Capital Partners is just about to announce its insurance plan, another California company, FOLI, four years ago introduced a plan with some similar elements, such as the purchase of life-insurance policies in the names of charity supporters, and a couple of key differences. Among the differences: Instead of counting on investors, the FOLI plan calls for the charity to provide or borrow the money needed to pay for the insurance policies.

The Palm Desert, Cal., company says the initials in its name stand for "foundation-owned life insurance."

In 1995, FOLI signed its first client: the Osteopathic Medical Center of Texas. Earlier this year, it attracted the Coachella Valley (Cal.) Society for the Prevention of Cruelty to Animals as its second client. And FOLI officials say that they expect about five more charities to sign on within the next 18 months as the company steps up its marketing efforts.

The animal group has borrowed $6.9-million to buy 1,000 life-insurance policies. So far, the charity has recruited 700 people -- chosen according to their age, gender, and how they fit into the insurance company's predictions of when people will die -- who have agreed to let it buy policies in their name.

Robert L. Sandifer, head of the group, says the charity, which is new and has plans to build an animal shelter, anticipates earning $64-million over 60 years.

The Texas medical center borrowed about $6-million and put up an additional $2-million of its own to buy 1,239 life-insurance policies on its employees and supporters of the hospital. Jay E. Sandelin, the center's chief executive officer, says that the charity expects to net roughly $200-million over 40 years, with the bulk of the money starting to accrue in 30 years.

"It seems on the surface too good to be true," says Mr. Sandelin. "But the concept is simple: If you pay the premiums on your policies, the money will come."

Some observers fear that the new insurance plans are indeed too good to be true -- and could cause a lot of trouble for charity participants. It is hard to judge the situation fully because few people have seen all the details of how the plans are structured. In the case of Capital Partners, the company requires its charity clients to sign confidentiality agreements promising not to reveal details of its program, called the LIFE (Life Insurance for Endowment) Heritage Plan.

Although Capital Partners wouldn't provide all the details to The Chronicle, it did provide an example of how it promises to generate $1-million a year for a charity.

The company says it would set up a trust in a charity's name and, with the help of investment managers, arrange for corporate investors to buy shares in the trust worth, in this example, a total of $205.2-million. The trust, which would be owned and controlled by the charity, would then use the money to buy life-insurance policies -- with a death benefit of $250,000 each -- on 5,000 participants who had agreed to have policies purchased in their name.

The charity, which would pay $100,000 in start-up administrative fees, would get $1-million a year for 30 years, plus, in the first year, the return of its initial investment. One or more beneficiaries named by the participants would receive a total of $10,000 upon the participant's death. The rest of the benefit money would be returned to the trust, and, in most cases, added to that portion of the insurance policies that could be used to make investments.

At the end of 30 years, investors would expect to receive $2.2-billion -- or a return of 8.3 per cent. What the investors receive can vary, though, as the cash value of the policies would depend on investment performance over 30 years.

Capital Partners would net a total of $1.4-million as soon as the plan was in place.

While the dollar figures may be enticing, legal experts say charities ought to be sure that the companies promoting the plans have found a way to deal with potential problems. Among the issues to consider:

Eligibility to buy insurance. The concept behind life insurance is that policies are purchased only by people or institutions that have an interest -- such as a relative, a business partner, or the like -- in the life of the insured. In many states, charities have the right to buy life insurance on their supporters and, in some cases, any potential supporters, too. Since state laws vary, however, the plans have to be sure they comply with "insurable interest" laws.

In addition, it may be illegal to circumvent insurable-interest laws by allowing a group of investors -- who otherwise could not buy life insurance on a random group of people -- to, in effect, buy the policies through a charity.

Securities. Because the Capital Partners plan calls for the charity to sell shares, or notes, to investors who are promised a rate of return on their investment, the trust created by the charity might be considered a security. As such, it would be subject to regulation under state and federal securities laws.

Taxes. Charities have to pay taxes on income that comes from a trade or business that is not related to their missions. Revenue from the investment plans may be deemed taxable and, more important, some charity lawyers say, a charity's tax-exempt status could be jeopardized if the income-producing business was found to be the charity's primary activity.

Undue financial benefits. Federal laws prohibit a charity from providing financial benefits to someone outside the organization -- unless that benefit is given as part of the charity's mission or as payment for a job performed for the charity.

Some lawyers say charities that engage in the plans might be violating that law by allowing the heirs of the charities' supporters to get the death benefits from the insurance policy. And, depending on the structure of the deals, the benefits received by the companies that broker the business, and the benefits received by the investors or lenders, might also be construed as illegal gains.

Beyond such legal issues, observers say that charities should consider some financial questions: Are the earnings projections offered by the companies too rosy? Are they using sound actuarial tables -- the projections of when people die that are the basis for the price of premiums and the schedule of death-benefit payments?

Eric Swerdlin, the president of Swerdlin White Huber, a Cedar Knoll, N.J., company that manages planned-giving assets for non-profit groups, says he has a lot of questions about the plans.

"If they are promising these fantastic results for everybody, who is at risk?" Mr. Swerdlin asks. "It has to be a zero-sum game, so off of whose backs are the returns coming? If it is the insurance company, maybe it won't be so solvent after 20 years. It looks like something would have to give. You just have to look for what."

Richard C. Johnson, head of FOLI, says that with his company's plan it is, indeed, the insurance company that is making less-than-usual profits on the deals. But, he says, the companies benefit from the increased business and the up-front payment of premiums that allows them to invest more money.

Allin M. Karls, chairman of Capital Partners, says his company's plan wouldn't have been feasible unless it had found a way to offer investors something beyond the promise of an 8-per-cent return after 30 years. Because of the way his plan is structured, he says, companies that invest in the program are able to take advantage of accounting rules that can help improve their financial picture. He declined to specify what those advantages were.

Mr. Karls also declined to describe exactly how the company plans to structure the charity- owned trusts. But, he says, the trusts in each case will be designed so that the charities involved will not have to pay unrelated-business income tax; that the money paid to the insured's beneficiaries or the investors will not be construed as a private benefit; and that insurable-interest laws are followed. In addition, he says, the company and the trust will be prepared to comply with securities laws if necessary.

Capital Partners' reluctance to reveal details of its plan has frustrated observers, including at least two state regulators. Frank M. Fitzgerald, Michigan's Insurance Commissioner, says that officials from his office met with Capital Partners earlier this year to discuss the agency's concern about the company's marketing materials.

"The information could leave questions in your mind of what is really going on," Mr. Fitzgerald says. He says his agency is still waiting to hear from the company, which had promised to contact the agency before it continued to market its program in Michigan.

Two years ago, in a letter to a charity considering the Capital Partners plan, Maine's Bureau of Insurance questioned the company's use of the confidentiality agreements, asking whether it was an "attempt to hide something from regulatory oversight." But Maine officials didn't follow up on a planned investigation of Capital Partners because the charity dropped talks with the company.

Mr. Karls of Capital Partners says that the company's closed-mouth policy and the confidentiality agreements are meant to protect the plan's business secrets against potential competitors. He points out, however, that when necessary, the company will willingly share information with government officials, such as the insurance regulators from four states with whom, he says, Capital Partners is now working to make sure its plan is legal. Mr. Karls declined to name the states.

Once the program is in place for at least several charities, Mr. Karls says, he and his company will be more forthcoming about the plan. In the meantime, he says, what is important to know is that the company -- after 12 years of work to develop the plan -- has not lost sight of its original goal: to help charities raise money.

"This is not geared for the investors to use the charity," says Mr. Karls, who has served on the boards of several non-profit organizations. "It's the other way around. Our clients are the charities, and we go out and find the investors that put up the money and wait 30 years to get their money, while the charities are taking their $1-million a year."

Officials at the Christian Medical & Dental Society simply hope that the Capital Partners plan works. The group spent two years and $20,000 checking out the company, working with lawyers, accountants, and auditors to determine if the plan made sense.

"We don't have a question of whether this is right or wrong," says Colette Davis, the society's finance director. "We do have some worry, though, whether this will be a sound investment that will pay off."